Economists discuss the impact of the stimulus on our recession

Summary: The US economy continues to slow, albeit the rate of decay has slowed. But the net damage is severe and a recovery soon is imperative — or more “black swans” will appear. This is the third in a series of posts about the effects of basic automatic stabilizers on the economy during this recession.

The stimulus programs were mis-sold to the public, since our ruling elites (”both” parties) are compulsive liars. Government aid cannot end recessions. It serves only to mitigate the downturn and reduce the inevitable suffering. The heavy lifting among these tools results from unemployment aid, Medicaid, and food stamps — focused on those that have suffered loss of income. This post gives some reviews of the performance of these programs during the past few months, in the context of the overall stimulus package.

Contents

This is a broad sample of analysis about this important question, not a complete listing.

Republicans are pushing back hard against today’s unemployment report, which showed a lowerr-than-expected 247,000 new jobless and the overall unemployment rate falling 0.1 points to 9.4% . Former McCain campaign economic adviser Douglas Holtz-Eakin spoke to reporters on a Republican National Committee-sponsored call to make the wonk’s case against reading too much into the report. “No real earnings growth in this report that would suggest sustained upward growth in this economy,” Holtz-Eakin said. “It cannot be considered good news that people left the labor force. If not for that, the unemployment rate might have creeped up to 9.6%, is my guess.”

Holtz-Eakin challenged Democratic rhetoric about the effect their policies have had in mitigating economic problems, though he allowed that “no one would argue that the stimulus has done nothing.”

The problem: Some Republicans have argued exactly that. In February, Dick Armey, the former House GOP majority leader who now leads FreedomWorks, predicted that the stimulus would actually worsen the economic picture. “Taking money out of the private economy,” Armey wrote, “either through taxes or inflation… and spending it in a way that doesn’t offset the loss of money with real economic gains is worse than doing nothing.” In July, Sen. Jon Kyl (R-Ariz.), the GOP’s whip in the Senate, suggested canceling the rest of the stimulus in a column that ran down the ways it seemed, to him, to be failing and wasting money.

From Wikipedia: Holtz-Eakin is an American economist, professor, former Director of the Congressional Budget Office and former chief economic policy adviser to Senator John McCain’s 2008 presidential campaign.

While some congressional Republicans and others are dubious about the success of the stimulus plan, economists generally agree that the package has played a significant part in stabilizing the economy. They are less certain about the size of the impact.

“It’s starting to play a role, helping us to have slightly positive rather than slightly negative GDP growth,” said Phillip Swagel, an assistant Treasury secretary in the Bush administration who is now a visiting professor at Georgetown’s McDonough School of Business. “It’s a gigantic amount of fiscal stimulus, and anyone who tells you it has had no impact, you should be skeptical of.”

IHS Global Insight, an economic consulting firm, estimates that the stimulus has increased the 2009 gross domestic product by about 1% over what it otherwise would have been, with the benefit almost entirely in the second half of the year.

The firm also forecasts that the package will, in total, result in about 2 million more jobs than otherwise would have existed at the end of 2010. Moody’s Economy.com estimates that the initiative will increase employment by 2.5 million jobs. Both estimates are below the 3 million to 3.5 million jobs the Obama administration estimated the package would create or save because the firms assumed more modest ripple effects from the stimulus spending than administration economists did.

Unprededented monetary and fiscal support is mainly responsible for the econoy’s upturn. The Federal Reserve’s aggressive actions helped stabilize the system. …

Fiscal policy is also providing significant support. Hard-pressed unemployed workers and fiscally strapped state and local governments would be cutting back much more if not for the federal government’s stimulus measures.

… All this has been costly — the federal budget deficit will approach $1.6 trillion this fiscal year, up frm $450 billion last year — but the cost to the economy and ultimately to taxpayers would have been measurably greater without it. The economy would still be in a deep recession if not for policymaker’s aggressive actions.

Another article by Zandi with the same message: “Boon or Boondoggle“, op-ed in the Philadelphia Inquirer, 11 October 2009 — “Critics are wrong: The stimulus is working. If anything, it wasn’t big enough, as job losses show.”

(2) Other economists’ views

(a) “Fighting Downturns with Fiscal Policy“, Federal Reserve Bank of San Francisco, 19 June 2009 – The best single thing I’ve read about our situation, a rare moment of intellectual honesty. Conclusion:

Earlier this year, Congress passed a $787 billion fiscal stimulus package spread over 10 years. Of that total, $584 billion are spent in 2009 and 2010, with 19% of the funds allocated toward increases in government spending, 33.4% in transfers to the states, and 47.6% toward tax cuts. The findings from the three empirical studies, particularly those of Romer and Romer and Mountford and Uhlig, suggest that the fiscal stimulus package will boost growth substantially over the next two years, partly because it includes sizeable tax cuts that can be implemented quickly and that have significant effects on output.

Nevertheless, the uncertainty regarding those estimates remains high. Several economists remain skeptical that fiscal multipliers–whether from spending or taxes–are very large (see, for instance, Barro 2009). Moreover historical relationships may prove much less reliable during this downturn. Faced with a large decline in wealth and tight credit availability, households may very well respond differently to tax cuts today than they have in the past.

How much do tax cuts and spending raise GDP? The widely cited estimates of Mark Zandi of Economy.com indicate a multiplier of around 1.5 for spending, with widely varying estimates for tax cuts. Payroll tax cuts, which make up about half the Obama proposal, are pretty good, with a multiplier of 1.29; business tax cuts, which make up the rest, are much less effective.

… And that gets us to politics. This really does look like a plan that falls well short of what advocates of strong stimulus were hoping for — and it seems as if that was done in order to win Republican votes. Yet even if the plan gets the hoped-for 80 votes in the Senate, which seems doubtful, responsibility for the plan’s perceived failure, if it’s spun that way, will be placed on Democrats.

I see the following scenario: a weak stimulus plan, perhaps even weaker than what we’re talking about now, is crafted to win those extra GOP votes. The plan limits the rise in unemployment, but things are still pretty bad, with the rate peaking at something like 9 percent and coming down only slowly. And then Mitch McConnell says “See, government spending doesn’t work.”

The question of how bad would economic conditions be right now if there had been no stimulus package and no financial bailout is receiving considerable attention. There’s no way to know for sure, but I believe the economy would have been much worse off without these two policy interventions. But without actually running the alternative scenario – something we can’t do – there’s no way to know for sure.

But one thing I am fairly certain of, and something I don’t think is getting enough attention, is the effect that automatic stabilizers have had in helping to ease the impact of the recession for individual households on and for the overall economy.

What are automatic stabilizers? Automatic stabilizers are taxes and transfers (e.g. unemployment compensation and food stamps) that automatically change with changes in economic conditions in a way that dampens economic cycles. For example, when the economy turns downward, the amount spent on food stamps automatically goes up as more people apply (or eligibility rules are eased), and the extra spending the food stamps helps to soften the downturn for the individuals receiving the help and for the businesses and employees where the money is spent (and then the multiplier process spreads the benefits more widely). Similarly, unemployment compensation, which obviously rises as jobs are eliminated, goes up when conditions deteriorate and that also provides a boost to demand. In addition, income tax as a share of GDP goes down in recessions and that helps to offset the fall in GDP as well.

How much worse would things be now if we had followed the advice of the hardcore rightwing and eliminated the welfare state programs that function so effectively as automatic stabilizers? It still wouldn’t be like the pictures you see of the Great Depression because we are a much wealthier nation than we were then and thus have more private resources to rely upon. But even so, not everyone has wealth to rely upon and the recession would be much more evident, and the amount of human suffering would be much greater, without the social insurance programs we put in place in the years since the Great Depression — programs that we, for the most part, now take for granted. I don’t mean there is no suffering due to the downturn, there is and I don’t want to minimize it – I wish our social insurance programs were even more generous than they are now for that reason – and I don’t mean to say there are no signs at all of economic problems, there are, but we shouldn’t overlook the important role that social insurance plays during recessions.

What has so far prevented a deep depression in 2009? The answer, as Paul Krugman explained yesterday, are automatic stabilizers. Indeed, as Hyman Minsky emphasized more than 20 years ago in his book Stabilizing an Unstable Economy (1986), this feature of the federal government’s budget – i.e. the fact that it moves counter-cyclically in an automatic fashion – imparts a great stabilizing force to aggregate demand.

(3) Analysis by the Council of Economic Advisors

These have the data and analysis on which other economists rely for their work.

Even if the Recovery Act is clearly working in the concrete, on-the-ground sense, there is still the question of whether we can see it in the overall performance of the economy.

Common Critique.

Here, I can’t resist pointing out the fallacy in a common critique. Throughout the spring, I frequently heard people say: “The unemployment rate is even higher than you all predicted without stimulus. That means the policy isn’t working and may actually be making things worse.” Even leaving aside the fact that we were always very clear that there was tremendous uncertainty about what would happen to the economy, that argument is – to quote a recent New York Times editorial – just plain “silly.”

To understand why, let me give you an analogy. Suppose you go to your doctor for a strep throat and he or she prescribes an antibiotic. Sometime after you get the prescription, and maybe even after you take the first pill, your fever spikes. Do you decide that the medicine is useless? Do you conclude the antibiotic caused the infection to get worse? Surely not. You probably conclude that the illness was more serious than you and the doctor thought, and are very glad you saw the doctor and started taking the medicine when you did.

That was exactly the situation with the economy. It is true that the U.S. and world economies went down much faster last fall and winter than we, and almost all other forecasters, expected. The revised GDP statistics show that the actual decline in GDP growth in the third and fourth quarters of last year was about twice as large as the preliminary estimates we had at the time indicated. And, the rise in the unemployment rate has been exceptionally large, even given the large fall in GDP that we now know occurred. The fact that the economy deteriorated between January when we were doing our forecast and the end of March simply reinforces how crucial it was that we took action when we did. …Cross-Section Evidence of Macroeconomic Effects
Because the evidence from the path of the economy over time can’t settle the issue of what the effects of the Recovery Act have been, it’s helpful to also look at other types of data. In particular, I want to mention two types of comparative evidence.Comparisons across Countries.

The first involves comparisons across countries. Countries’ responses to the crisis have varied substantially. One can therefore ask whether countries that have responded more aggressively seem to be recovering more quickly. To get evidence about this, we started with a set of forecasts of growth in the second quarter of this year that were made last November – after the crisis had hit, but before countries had formulated their policy response. We then collected analysts’ recent best guesses for what second-quarter growth will be in those countries.17 This figure shows the relationship between how countries’ second-quarter growth prospects have changed from what was expected back in November, and the countries’ discretionary fiscal stimulus in 2009.

The fact that the observations lie along an upward-sloping line shows that, on average, things have improved more in countries that adopted bigger stimulus packages. And, the relationship is sizable: on average, a country with stimulus that’s larger by 1% of GDP has expected real GDP growth in the second quarter that’s about 2 percentage points higher relative to the November forecast.

This correlation is in some ways surprising, because there’s an obvious element of reverse causation that’s pushing it the other way: countries that got worse news around the turn of the year probably adopted more aggressive stimulus packages. Also, to the extent that analysts back in November could foresee countries’ likely actions and take them into account in making their forecasts, this would cause the relationship to understate the effect of stimulus. But despite these factors tending to bias the estimates down, the relationship is highly statistically significant, large, and robust to changes in the sample and in the measure of forecasted growth. …

What Can We Expect Going Forward?

So much of what I have discussed has focused on the role of the Recovery Act in moderating the GDP decline and saving jobs in the second quarter of 2009. The obvious next question is, what can we expect going forward?

Effects will Increase over Time.

First, the impact of the Recovery Act will almost certainly increase over the next several quarters. We expect the fiscal stimulus to be roughly $100 billion in each of the next five quarters. The impact of this steady stimulus, however, will increase over time because the multiplier effect tends to rise for a substantial period before beginning to wane. Also, the composition of the stimulus will be changing toward components with larger short-run effects. The early stimulus was weighted more heavily toward tax changes and state fiscal relief, whereas going forward there will be more direct government investments. These direct investments have short-run effects roughly 60% larger than tax cuts.

Forecasts.

Second, because of the Recovery Act, other rescue measures we have taken, and the economy’s natural resilience, most forecasters are now predicting that GDP growth is likely to turn positive by the end of the year.20 Federal Reserve Chairman Ben Bernanke seconded this opinion in recent Congressional testimony.21 This view is supported by the fact that a number of leading indicators, including initial claims for unemployment insurance, building permits, and consumer confidence, have improved substantially over the past few months. However, as is always the case, especially around a turning point, there is substantial uncertainty to this forecast. There is even greater uncertainty about how strong the recovery is likely to be. The strength will depend on a range of factors, including how fast the economies of our trading partners recover; whether American consumers decide to increase their savings rate even more than they already have; and how quickly financial markets and business confidence return to normal levels.

Continued Job Loss.

Third, it is important to realize that job growth will almost certainly lag the turnaround in real GDP growth. The consensus forecast is for the employment statistics we get tomorrow to show that the U.S. economy continued to lose hundreds of thousands of jobs in July. Given that GDP growth was still negative in the second quarter, this is all but inevitable. And, it is unacceptable. Unfortunately, even once GDP begins to grow, it will likely take still longer for employment to stop falling and begin to rise.

Recovery Will Take Time.

Fourth, and crucially, given how far the economy has declined, recovery will be a long, hard process. Even if GDP growth is relatively robust going forward, it will take a substantial time to restore employment to normal and bring the unemployment rate back down to usual levels. But, the President is committed to job creation, and that is and has been a focal part of our efforts.

The bottom line.

We are no doubt in for more turbulent times. The actions we have taken, particularly the American Recovery and Reinvestment Act, have clearly changed the trajectory we are on. They are doing what the President always said needed to be our top priority – rescuing an economy on the edge of a second Great Depression. And, I firmly believe that when the history of this period is written, the Recovery Act will be seen as the beginning of the end of this terrible economic crisis.

Evaluating the impact of countercyclical macroeconomic policy is inherently difficult because we do not observe what would have happened to the economy in the absence of policy. And the sooner the evaluation is done after passage, the less data one has about key economic indicators. Any estimates of the impact of the ARRA at this early stage must therefore be regarded as preliminary and understood to be subject to considerable uncertainty. In this regard, it is important to note that there has not yet been any direct reporting by recipients of ARRA funds on job retention and creation. Such direct reporting data will be evaluated and incorporated in future reports.

Because of the inherent difficulties in the analysis, we approach the task of estimating the impact of the Recovery Act from a number of different directions. Our multi-faceted analysis suggests that the ARRA has had a substantial positive impact on the growth of real gross domestic product (GDP) and on employment in the second and third quarters of 2009. That various approaches yield similar estimates increases the confidence one can have in the results.

Among the key finding of the study are:

As of the end of August, $151.4 billion of the original $787 billion has been outlaid or has gone to American taxpayers and businesses in the form of tax reductions. …

The areas where stimulus has been largest in the first six months are individual tax cuts, state fiscal relief, and aid to those most directly hurt by the recession. That recovery funds have gone out rapidly certainly increases the probability that the Act has been effective in its first six months.

Following implementation of the ARRA, the trajectory of the economy changed materially toward moderating output decline and job loss. The decomposition of the GDP and employment change by components or sector suggests that the ARRA has played a key role in this change of trajectory.

Estimates of the impact of the ARRA made by comparing actual economic performance to the predictions of a plausible, statistical baseline suggest that the Recovery Act added roughly 2.3 percentage points to real GDP growth in the second quarter and is likely to add even more to growth in the third quarter.

This analysis indicates that the ARRA and other policy actions caused employment in August to be slightly more than 1 million jobs higher than it otherwise would have been. We estimate that the Act has had particularly strong effects in manufacturing, construction, retail trade, and temporary employment services. …

In addition to the estimates based on statistical projection, we provide estimates of the effects of the ARRA from standard economic models. Both our multiplier analysis and estimates from a wide range of private and public sector forecasters confirm the estimates from the statistical projection analysis. There is broad agreement that the ARRA has added between 2 and 3 percentage points to baseline real GDP growth in the second quarter of 2009 and around 3 percentage points in the third quarter. There is also broad agreement that it has likely added between 600,000 and 1.1 million to employment (again, relative to what would have happened without stimulus) as of the third quarter.

Fiscal stimulus appears to be effective in mitigating the worldwide recession. Nearly every industrialized country and many emerging economies responded to the severe financial crisis and recession by enacting fiscal stimulus. However, countries differed greatly in the size of their fiscal actions. We find that countries that adopted larger fiscal stimulus packages have outperformed expectations relative to those adopting smaller packages.

State fiscal relief was one of the ways in which the Recovery Act was able to provide support for the economy most quickly, and it played a critical role in helping states facing large budget shortfalls because of the recession. Our analysis indicates that state fiscal relief increased employment at the state level relative to what would have happened without stimulus. Thus, this analysis both provides evidence of how one particular type of fiscal stimulus impacts the economy and corroborates the more fundamental finding that fiscal stimulus in general is an effective countercyclical tool.

16 thoughts on “Economists discuss the impact of the stimulus on our recession”

Comments by all the same fools whose advice caused this mess. Are they too stupid to realize that had the government spent even more money the GDP would have went up even more. I recommend we build a fence with a giant continent spanning moat on the border, and also use all those free contain ships to bring Mexicans into the country by sea to build the fence. We should print and borrow money to do so. That’ll up the GDP.

The GDP is only an approximate measure of economic health where the government is not cooking the books with make work and misallocation of resources.
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.Fabius Maximus replies: These people represent a wide slice of America’s A-team economists. But they’re just not you. Wonderful you.

A shorter version of your last sentence works even better (and requires less proof): “The GDP is only an approximate measure of economic health”.

The interesting thing is that there appears to be almost no structural reform. Not even of the financial system. Quite different to the rapid changes brought in to other countries in past crises. There isn’t even talk of reform.

The assumption seems to be that the economy is fundamentally sound and nothing really needs to be done. Or perhaps that the reforms needed are just too hard and long term and the stimulus hasn’t got any chance of covering them.
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.Fabius Maximus replies: I agree. Very remarkable! The time for reform is while the pain is fresh in people’s minds, their outrage strong enough to overcome the cash contributions of the finanical industry. I fear that moment might be slipping away. More “status quo policy” from what conservatives tell us is that leftist anarchist radical Obama.

Wrong the sentence was better as it was. GDP is only an approximate measure of economic health with free markets. With increasing intervention the approximation becomes less and less accurate. That is why my sentence included cooking the books. Government programs to buy pigs up from farmers, slaughter them then bury the meat, using government printing presses to pay for the program will indeed increase GDP, but will not be good for the economy. This is not something the free market would entail.

Where government is limited to enforcing the law and protecting from foreign invaders, and with voluntary transactions one is much less likely to get behavior based on the broken window fallacy like cash for clunkers, or stupid price controls like the extra low interest rates we now enjoy.
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.Fabius Maximus replies: While I agree with most of your points, mine was more fundamental. GDP is but one metric, and not necessarily the best, to evaluate the economy. And its not esp useful as a measure of anything broader, such as our prospertity or economic vitality. It’s only one measure, and a highly conceptual one.

Thanks for the analysis but it is totally wrong. You probably are not reading this, but if you want to actually understand how the economy works you need to forget all your financial overlays and think about the world as a barter system (this does not work for monetary policy). You will see that all a stimulus does is redirect capital around and because government is inefficient, it tends to do it inefficiently. True impact of every dollar spent after crowding out will be roughly

So if the capital is being directed to build and destroy something that would be zero efficiency. We can see that if the government could redirect capital around better than individuals, the country would be richer if it was communist. This is empirically false. We can also see that the greater the under utilization the better a stimulus works. However, since the efficiency of government is so small compared to the efficiency of the economy because it does not redirect capital where it is actually needed, that a stimulus usually is a poor decision.

This is just illustrative — the model needs to include some measures for land and labor as well.

GreySwan
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.Fabius Maximus replies: Perhaps all these economists are wrong. Perhaps all economists are wrong, and you are right. This is, however, not a theory I have any interest in.

Is the collection of economists really that broad? They are economists that are generally affiliated with the two political parties, fall into the categories of Keynesians and Monetarists, and didn’t really see this coming. And you could probably write a post about QE and find similar levels of support/agreement from this group.

But you fail to mention folks like Nassim Taleb, Marc Faber, Albert Edwards, Steve Keen, William Buiter, Julian Robertson and others (like a host of bloggers) who sounded the alarm on this debt-induced balance sheet recession and are now highlighting the folly and lack of efficacy in the current fiscal and monetary measures.

The convention of the last 70 years (very well illustrated but the examples you cite above) has brought us to this episode of economic failure, and we are trusting that same convention to lead us out. For now.
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.Fabius Maximus replies: First, this was 4,000 words. Articles on this site are probably longer than those of most similar sites on the Internet.

Second, the Republican-affiliated ones were deliberately chosed to foreclose the inevitable accusation that the economists chosen were politically motivated.

Third, consider the names you mention.
* Taleb and Robertson are not economists.
* Faber and Edwards were trained as economists, but are an investment manger and strategist, respectively. As such neither have commented on the narrow proposition I discussed here, but I suspect both would agree.
* Buiter and Keen are practicing economists. I don’t read their work, but I suspect that they too would agree with this narrow proposition.

In fact, almost all economists would agree. It’s a firmly established and well-researched dynamic. Economists disagree about the longer-term and broader effects of the stimulus — as shown in “Fighting Downturns with Fiscal Policy“, Federal Reserve Bank of San Francisco, 19 June 2009 (see except in the post).

Update: I have added a comment below about Buiter’s views. He’s strongly in favor of automatic stabilizers, as described in my posts.

Brian Macker remarked “Comments from all those fools that caused this mess,” to which you responded with snark that seems unjustified.

As Brown points out farther on, we are not hearing from a large variety of economists. Brown only mentions the outliers like Taleb, but a vast swath of mainstream economists intensely critical of the current bailout have reportedly been shut off and denied access to Obama by Geithner and Summers.

Those mainstream economists include Joseph Stiglitz, a Nobel laureate in economics, and Paul Krugman, another Nobelist, and Paul Volcker. (Before you ridicule the Swedish medal for economics in memory of Alfred Nobel, bear in mind that you have implicitly invoked the appeal to authority by ridiculing Macker for his alleged lack of credentials; have donse so, you cannot therefore now turn around and dismiss the sterling credentials of critics of the current bailout.)

To bolster Macker’s assertion that the economists around Obama are “idiots,” let’s take a look at their track record. Larry Summers masterminded the “shock therapy” conversion of the USSR’s economy to capitalism. This was one of the greatest economic catastrophes in history, resulting in the theft of most of the USSR’s wealth by seven oligarchs, and has directly results in the crash of the life expectancy in the former Soviet Union and rampant poverty. Later, Summers served as president of Harvard university, a position he directed with such skill that he was thrown out on his ass.

By what standard does Larry Summers deserve even to manage an ice cream stand? Larry Summers’ track record does not qualify him to manage a 7-11. The article Larry Summers: Brilliant Mind, Toxic Ideas sums it up nicely.

Macker and Brown are correct on this one. Stiglitz has a proven track record successfully managing the World Bank, while Geithner and Summers have managed to destroy essentially every economic entity they’ve touched (while enriching themselves, however).
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.Fabius Maximus replies: McLaren, I am disappointed in you. First, I would expect you to support this post — which advocates the use of automatic stabilizers, of a sort Econ 101 textbooks have described as routine and non-controversial for decades. Instead you stand shoulder-to-shoulder with those who oppose them. No wonder progressives can get nothing done in the US.

(2) “To bolster Macker’s assertion that the economists around Obama are “idiots'”Most of these people have distinguished careers with substantial accomplishments — like Chistina Romer and Summers. To say that does not mean agreement with their politics or policies, but simple recognition of reality. These men and women are just regular folks, running a complex nation in a rapidly changing world — using highly imperfect data and relying on immature economic theory. They make mistakes, but that does not make them “idiots”.
This is the sort of nonsense heard at ballgames, where overweight couch potatoes ridicule the players as clumsy oafs. If you cannot see this, please don’t post comments on this site. You have convinced me that this sort of name-calling should be deleted in the future, instead of replying with snark.

(3) “but a vast swath of mainstream economists intensely critical of the current bailout”But this post is explicitly not a discussion of the overall bailout, but only one part of it. Why don’t you give us some excerpts of those economists who disagree with the use of automatic stabilizers? Brown does not. You do not.

(4) “Before you ridicule the Swedish medal for economics in memory of Alfred Nobel”This is absurd, not justified by anything I’ve said. You’re the one mocking distinguised people

(5) “Those mainstream economists include Joseph Stiglitz, a Nobel laureate in economics, and Paul Krugman, another Nobelist, and Paul Volcker.”
I am familiar with the work of all these people, and none of them have said anything remotely like contradicting the proposition discussed here. You’re just making stuff up.

(6) “a vast swath of mainstream economists intensely critical of the current bailout”Perhaps you have not read this post, nor much on this site. This is not a defense of the overall bailout, but a far more narrow proposition. I’ve only said that in these comments a dozen or so times. And discussed this in several dozen posts, at great length.

(7) “Stiglitz has a proven track record successfully managing the World Bank, while Geithner and Summers”While I am no fan of Geithner and Summers, it is absurd to compare running the World Bank to setting economic policy for the USA.

“The time for reform is while the pain is fresh in people’s minds, their outrage strong enough to overcome the cash contributions of the finanical industry.”

The time for reform is when credible alternatives stand waiting in the wings. People would rather bear those ill they have than flee to those they know not of. For an illustration of this phenomenon, study the comments relating to FM’s above post about why the dollar is not going to be replaced for oil purposes.

The maxim “out with the old; in with the new” is incorrect; the correct maxim should be “in with the new; then out with the old.”
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.Fabius Maximus replies: We had a perfectly good regulatory system for the financial system, which was sytematically dismantled during the 1990’s and early 2000’s in order to boost profits of financial firms. Restoring the old system would be a reasonable initial step.

I have been an infrequent reader of your blog for the last year or so, but I am making a point of checking it more frequently, as I am of the view that the evolving global financial mess will drive and be driven by increasing geopolitical tensions. Your blog is a great read for that global perspective.

I read the point of your post to say that stimulus cushions the blow of the recession and that economists across the Republican and Democratic spectrum acknowledge the same; that economic history since WWII has shown the type of correlation between stimulus and subsequent change to GDP.

A different view is that this recession is unlike any US recession since WWII, and hence the historic correlations do not apply. The difference? This is a balance sheet recession; all other recessions since the Great Depression have been rooted in inventory correction cycles. Faber says this point is missed by guys like Krugman (i.e. he critiques recent 6000 word piece where Krugman talks about stimulus saving the world yet never once mentions the role of debt — see recent interviews with Bloomberg and CNBC). If there is neither demand for nor supply of new debt (due to too much debt in the system), the stimulus cannot have their historic effect. Is there proof that this has happened with the stimulus? Unemployment is already above where the stimulus planners said unemployment would peak without the stimulus. That is not a statement nor proof that the stimulus has had no effect, but it is a data point consistent with fiscal stimulus not producing effects in line with “historic” norms.

An alternative approach to stimulus would be using political capital (as well as the government’s balance sheet) to drive debt-to-equity conversion on a massive scale. While you could argue this has been done to a degree (e.g. autos, Citibank), it has not been implemented broadly in the financial system, not with home owners, and not with holders of US sovereign debt.

Coming back to the geopolitics, fiscal and monetary stimulus is paid for in 2009 through $1.75T of quantitative easing. While that should make everyone uneasy, including foreign holders of US debt, everyone goes along for now since $1.45T of that QE is for MBS and agencies. Foreign central banks like that because they can sell their MBS/agencies to the Fed at a great price, and then they turn around and purchase freshly issued Treasuries. That is a great way to run a $1.5T deficit without having the Fed directly purchase the entire shortfall.

But that is a one-trick pony. Once FCBs have completed rotation out of agencies into Treasuries (and into the short end I might add), QE will switch from a convenient mechanism to a direct threat on their holdings. 2010 is where this gets interesting. We will see what we can then afford: Stimulus 1.0, 2.0, whatever.
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.Fabius Maximus replies: All good points, which have been discussed at length in other posts.
* For more about Fisher’s theory of debt deflation, see Debt – the core problem of this financial crisis, which also explains how we got in this mess (one of many posts about the role of debt in this crisis).

I doubt that you can find many (if any) economists who disagree with this post, that the core automatic stabilizers (food stamps, medicaid, unemployment insurance) have served to mitigate the downturn and minimize suffering. There are dozens of comments like yours on this site. None have provided a shred of evidence or cited expert analysis. It’s some sort of superstition — flat earth theory — that has become established in some circles.

The rest of your analysis concerns one tiny fragment of the situation, in a misleading fashion. Since the GSE’s are de facto government owned and de jurre government controlled, foreign central banks exchanging GSE paper for treasuries has little overall effect. Saying that asset purchases by the Fed or government increase the gov’s deficit is true, but only under the primative cash-based accounting used by the US government. This crude system also prevents consolidation of GSE’s into the government’s books — even if they had a large net value (hence boost its creditworthiness), the net public debt would skyrocket. In sort, the actual situation is far more complex.

And now, for something completely different…Let’s talk about “Chartalism”. In 1929 the dollar was, literally, gold, but economic forces pushed economies one by one off from gold. Demonstrably, those who broke with gold sooner recovered sooner. By 1971, all explicit linkages between dollars and gold were broken, again due to ineluctable economic forces. An economic school called “Chartalism”http://bilbo.economicoutlook.net/blog/?p=5224
argues that today, even though all modern nations use pure fiat money, they still erroneously cling to the notion that this fiat money needs to maintain some semblance of “reality” as though it were still backed by gold, but just kind of sort of like, in a very politically enmeshed and dysfunctional reasoning/justification process. This leads to statements like, “Fiscal deficits-bad…surplus-good”, with increasingly tortured logic for support. This emotional longing for and attachment to the last vestiges (in our currency system) of an ancient and obsolete gold based currency, they argue, is what’s killing us today. I’ve been reading this stuff, and it’s making more and more sense. Bottom line? More deficit spending please. Now!

Fabius Maximus replies: For the ten thousandth time, we’re discussing the core automatic stabilizers — foods stamps, medicaid, unemployment insurance, etc — not the broad stimulus package. There are dozens of other posts on this site about the broader aspect of the play. Post this stuff there. Note, however, the articles in this post discuss these things far more clearly — esp the Fed letter (2a in the post).

All further posts listing names with what you think they would say will be deleted in their entirity, unless you provide either evidence or a power-of-attorney from each economist. This is the cheapest sort of rhetoric, listing names whom you guess believe you’re nifty.
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The quotes above provide some reasonable evidence that the stimulus package has improved GDP somewhat at this point.

This, however, is the least controversial part of the stimulus plan. It’s not really a surprise that borrowing money and spending it will temporarily lift GDP. The question is whether it will become harmful in the medium to long term, and whether overall it will have been a net benefit or a net drain on the economy.

FM: When paramedics come to you after a heart attack, be sure to first discuss the long-term effects of CPR.

Let’s revisit the basic arguments for a moment. The argument in favor of a stimulus is that without it, the economy will shrink so far that productive capacity will be lost that you would rather have retained once the economy recovers. The argument is that by borrowing to sustain the productive capacity of the country, you will find that after a few years GDP will be higher than it would have been without the stimulus.

The second argument is that the stimulus will have a multiplier effect, acting as a catalyst to stimulate economic activity, returning more in GDP in the short term than it cost.

If the combination of the multiplier and the prevention of the loss of permanent productive capacity in total is greater than the cost of the stimulus in terms of economic distortions, interest payments and other negative effects, the stimulus can be said to have been a success. In short, will Americans be better off ten years from now for having engaged in economic stimulus, or will they be worse off?

So far, the best that can be said about the stimulus is that it seems to have had a bigger short term positive effect on GDP than its negative effects. So you could say that there is now evidence that all the borrowing didn’t crowd out private capital, and that the effects of distorting the economy, sidelining investment, and other potential early negative effects of a stimulus package were outweighed by its positive effects.

But even that much isn’t totally clear – the part of the stimulus that has been spent so far is the part that most economists agreed would have the best chance of doing good – tax cuts and direct payments to people who are out of work. Even many opponents of the overall stimulus package, including myself, would have been in favor of a stimulus of maybe half to a third the size of the final package, consisting of direct aid to people who needed it the most and therefore have the largest marginal propensity to consume.

The more controversial elements of the stimulus package have not yet been implemented in large amounts. That would be the large grab bag of liberal programs, ‘community development’ funds, questionable infrastructure projects, ‘investments’ in green technology, civil works projects that mandate the paying of union wages, etc. Most of those have been loaded up for 2010, when their major effects will be felt just before the election.

We have yet to see what the negative effects of the stimulus will be. What happens to all those government jobs created with temporary stimulus money? What happens to all the new schools being built when the money runs out to put teachers in them? What happens if (when) those infrastructure projects start running over budget? What happens if the huge amount of borrowing to pay for it all causes a flight from the dollar or causes the dollar to lose its standing as the world’s reserve currency?

Finally, there have been several studies released since the stimulus was passed which suggest that fiscal multipliers will not be anywhere near what the administration says they will be. A recent paper from the London School of Economics says that a fiscal multiplier of 1.5 such that Christina Romer predicts, can only happen in a country with a fixed exchange rate. Countries with free trade and floating exchange rates could see their multiplier be essentially zero. Robert Barro wrote a paper in January using another methodology to predict a very low multiplier. Kevin Murphy of the University of Chicago predicted a multiplier of less than one back in January.

If the multiplier winds up being less than one, this is going to be one hell of an expensive ‘stimulus’ in the long run. It’ll be ‘cash for clunkers’ writ large, with a big hangover coming once the money runs out.

It would be interesting for you to do another post showing the current opinions of those economists who opposed the stimulus in the first place, none of which are quoted above. You could start with:

There are a few Nobel prize winners on that list. Surely their current opinions are worth at least as much as those of say, Phillip Swagel of Georgetown University or the economists in the administration who drafted the plan in the first place.
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.Fabius Maximus replies: Odd that you include Buiter in your list. I have added a comment below about Buiter’s views. He’s strongly in favor of automatic stabilizers, as described in my posts. This raises doubt about those other names. Did you really check their views?

FM: “We had a perfectly good regulatory system for the financial system, which was sytematically dismantled during the 1990’s and early 2000’s in order to boost profits of financial firms. Restoring the old system would be a reasonable initial step.”

The regulations which you cite were the product of the New Deal / Keynesianism. Worthy products for their time, but that time passed in the 1970’s. The New Deal / Keynesianism was replaced by Reagan / supply side. This, too, passed sometime during Bush / Cheney – certainly by the current downturn ( earlier, IMHO ).

The decline of Reagan / supply side does not entail the revival of New Deal / Keynesianism. Rather, absent some new structure, it entails a situation best described by Anglo-Saxon epithets.
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.Fabius Maximus replies: By the numbers.
* First, the major regulatory changes to the financial system came in the Clinton-Bush years, not earlier.
* Second, financial regulatory systems are not well described by Supply Side or Keynesian.
* Third, I don’t see why the New Deal regulatory regime was outdated — other than the need to modify it to address structural changes. Third, this is of-topic for this post. A brief reply is ok, but this is not the place for such a complex discussion.

It is a question of effectiveness for the real and political capital employed. My early data point on stimulus effectiveness is the shortfall on employment relative to forecast both w/ and w/o stimulus. It is a fact that for decades GDP growth has required ever accelerating growth in total debt. You can also see from the FRB’s report from 1Q09 that total credit growth was barely positive and would have been negative were it not for increased government borrowing. The 2Q09 report showed credit contracting at ~$1T annual rate even with massive increases in government borrowing. That does not auger well for near-term GDP growth. But we will see.

I really don’t understand the flat earth comment. This is a matter of how similar this downturn is to the US in the 30’s or Japan in the 90’s, and whether or not the policy responses will create a better outcome this time around. The followers of Keynes and Friedman have claimed we could avoid a debt deflation cycle. We are going to see if they are right.

I think you completely miss my point on QE. If the Fed wants to swap Treasuries for MBS, or if the Treasury wants to issued debt in order to purchase Citigroup common stock, I am not including that in the Fed gov deficit or in the QE numbers. But the ~$1.5T deficit projection for 2009 excludes Treasury borrowing for the purpose of asset purchases; and the $1.75T of QE excludes any other swaps/sales/purchases of assets the FRB may have done with its balance sheet.

The Federal deficit is projected >$1T annually for several years. MBS/agency QE-enabled rotation in Treasuries provided cash flow to fund the 2009 deficit without outright and direct monetization of net Treasury issuance. That dog won’t hunt come 2010. With FCBs accumulating dollar reserves at a much lower rate than they did pre-2008, and with those same FCBs comfortably weighted in the short end of the yield curve, how do you think they will react to QE 2.0, 3.0, etc., each in magnitude of >$1T and with an overweight towards Treasuries as opposed to MBS? Or if you don’t think QE 2.0, 3.0 is on the horizon, what will be the mix of purchasers for Treasuries in 2010-2012 and the resulting rate on the long bond?
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.Fabius Maximus replies: There are dozens of posts discussing broad or narrow aspects of these things. Find a relevant one at which to post comments. Your point about the decreasing marginal elasticity of GDP with respect to debt was discussed at length in…
* Death of the post-WWII geopolitical regime – death by debt
* Causes of the financial crisis (no, its not the usual list)

This stuff is all off-topic here — see the summary at the top. The rules of this site are designed to facilitate focused discussions. Please see the Comment Policy for details.

Here is the wiki link on Chartalism. Strange? Yes. Crazy? Amazingly, maybe no.
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.Fabius Maximus replies: It is a very common belief, although many adherents have not heard it and don’t examine their assumption to see their adherence to its doctrine. It is the fundamental operating doctrine of the US accounting system, justifying the government’s use of cash accounting (statutory fraud for a corporation). The government has no true liabilities, since it can either print money without limit to meet them — or just default (there is no superior authority to enforce contracts on the government).

“Third, this is of-topic for this post. A brief reply is ok, but this is not the place for such a complex discussion.”

Very well. Since you have played the “this is off topic” card, I will boldly go astray.

Musing upon my statement that the current situation is best described by Anglo-Saxon epithets, I note that rap music lyrics, on the one hand, and Anglo-Saxon alliterative verse, on the other, share strikingly similar metrical qualities.

So this suggests strongly where English poetry may be heading.
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.Fabius Maximus replies: Great stuff! Best analysis I’ve seen in years.